How credit cards can burn a hole in your pocket

First of all, banks bear a higher risk of default as a result of the unsecured nature of the credit card.

BankBazaar.com | Last Updated: December 27, 2012 17:56 (IST)

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The rate of interest on credit cards almost always towers over that charged for personal loans and home loans. There are several reasons behind this progression, which has rendered the credit card to be approximately three times more costly than home loans, or other regular loans.

First of all, banks bear a higher risk of default as a result of the unsecured nature of the credit card. Also, Indian credit card rates are said to burn a larger hole in the pocket as compared to credit card users in the US. This difference in rates can be attributed towards the service taxes, which can be as high as 12 per cent, that are charged towards the rate of interest on credit cards. Luckily, this is not yet applicable on the interest of different categories of loans. Often, Indian banks charge the same rate of interest for all classes of credit card users, regardless of individual credit card profiles.

With the glorious entry of rate differentiation in the market, credit card users can now breathe easy as this situation of demanding exorbitant rates of interest is likely to mellow down soon in the credit card industry. Rate differentiation will be charged as per the payment history of credit card users, thereby making it less burdensome while making credit card payments.

One of the major causes behind these exorbitant rates is the price inelasticity that is involved in borrowings made through a credit card. In short, credit card users demand convenience rather than any other major feature, causing a price hike in the market. Many are ignorant to the extent that they are unaware of the current rates of interest charged to them or choose to simply overlook it, concentrating on paying off their borrowing as soon as possible.

As people often borrow small amounts of money from their credit card, even with exorbitant interest rates levied on the amount, the figure looks quite small on a monthly basis. Thus, many consumers choose to overlook this amount, as they don’t bother to go through and analyze the actual rate of interest and its viability in the long run. But if you look at the big picture, then in the long run, with high rates of interest levied over your borrowing, it will take a lot more time to pay off the amount entirely.

Thus, as a wise consumer, you need to believe that the credit card is an important tool or instrument that is primarily used for the purpose of making payments. However, it must be used only on an emergency basis, when the situation demands for it. Otherwise, opt for alternative modes of payment to clear your dues. Also, in case you use credit cards as an instrument of borrowing, try and shorten the usage period as much as possible.

In a situation wherein you aren’t in a position to repay the entire amount that is due on your credit card, opt for a personal loan instead to clear your dues. But remember, it is always best to avoid a situation where you need to opt for more debt to clear another debt off. You might be in a situation where in your financial management can go haywire, not allowing you to concentrate on any financial investment since your entire finances will be redirected towards repayment of not only the new debt but also the old debt.

As a prudent customer what you need to know is that any credit borrowing now and a default on the same can have long-term implications on your future credit requirements. Therefore, make sure you repay your debt on time and try not to default on your payments.

Disclaimer: All information in this article has been provided by BankBazaar.com and NDTV Profit is not responsible for the accuracy and completeness of the same.